Offering credit to your clients potentially increases your sales base, and, in some cases, it’s the industry standard, meaning there’s virtually no way to avoid it. Unfortunately, however, the delay between issuing the invoice and receiving payment can cut into your working capital. If you’re staring at a stack of unpaid invoices wondering if there’s a way to turn them into cash, it’s time to consider factoring. Here’s how it works:
Factoring Turns Accounts Receivables into Working Capital
The factoring process is simple – you turn your accounts receivables over to a factoring company and the factoring company gives you cash based on the value of your unpaid invoices. In most cases, factoring companies forward about 75% of the total value of the invoices you are trying to collect. For example, if you have $10,000 in unpaid invoices, the factoring company may give you a $7,500 advance.
As your clients pay these invoices, the factor pays you the remainder of the balance minus its fee. In most cases, factoring fees cost between 2 and 6% of the total collected. To continue with the above example, once all of your invoices have been collected, you receive an additional payment worth between $1,900 and $2,300. In total, this means you have received between $9,400 and $9,800 in exchange for your $10,000 worth of accounts receivables, but, instead of waiting for the funds, you received most of them upfront.
Factoring Fills Your Business Coffers Quickly
The application for a factoring loan is traditionally much faster and easier than applying for a business loan. Rather than meeting with lenders, drafting a business plan and gathering all of your financial documents, you rely solely on the value of your unpaid invoices.
Online factors in particular tend to approve factoring loans very expediently, and these loans fund quickly as well. In many cases, businesses have the operating capital they need within a day.
Factoring Doesn’t Increase Your Debt Load
Unlike other business loans, factoring doesn’t increase your debt load. Instead, factoring just turns accounts receivables (an asset on your balance sheet) into cash. In addition, because you pay factoring loans upfront with your invoices, you don’t’ have to worry about juggling more monthly payments or increasing your debt liability in general. That also helps preserve your operating capital so you can spend it on the things you need rather than on loan repayments.
Similarly, as factoring loans aren’t based on your business or personal credit rating, you don’t have to worry about being rejected on the basis of your creditworthiness and that can take a lot of uncertainty out of the application process. However, it’s important to note that some factoring companies look into the creditworthiness of your clients, and they may request information on your client’s payment histories before they extend a loan.
Factoring Companies Give You Relief from Debt Collection Activities
Some factors give you an advance on your invoices, and then they simply wait for the invoices to get paid per usual. In other cases, once the factor gives you the advance, they start trying to collect on your invoices. If you work with a factor that does the latter, it lifts the burden of debt collection activity from your business.
Rather than calling old clients to recoup old debts, your staff can direct their talents in other places. That potentially saves payroll hours, allowing you to focus that portion of your operating capital on other critical areas of your business.
Factoring Offers Multiple Options
Many factors offer a lump sum advance, followed by small payments as the invoices are paid, but, in other cases, factors offer a business line of credit. With a line of credit, you receive access to all of the advance payment from your invoices, but you don’t have to spend all of it. As a result, you don’t pay fees or interest on the amount that you don’t spend.
Many businesses prefer this level of flexibility, as they can take out operating capital when they need to pay employees, buy office supplies, cover utility bills or take care of other current expenses, but if they have a lot of sales one week and they don’t need the boost from their factoring line of credit, they can leave it untouched.
Factoring is Not for Everyone
Although factoring can be an effective way to access operating capital without taking out a loan, it isn’t the right choice for every business. If you already have access to a personal or business line of credit with a lower interest rate than the factor’s fee, it’s more cost effective to use that instead. Similarly, if you don’t want to cut into your profits and you have time to spare, you may just want to wait until your clients pay their invoices. Additionally, in some cases, factors set minimum limits, and they only work with companies who have a certain value of invoices. If you don’t meet the threshold, you may also want to explore alternative options.
Accounts receivables are an asset on paper, but they offer no help when you have a pile of current bills to pay. Factors can eliminate this issue by turning your accounts receivables into cash. If your operating capital needs a boost and you don’t have the time or desire to take out more debt, factoring can be the best option.